Cat bonds help California Earthquake Authority to offer rate reduction

The California Earthquake Authority (CEA), the publicly managed residential earthquake insurance provider, is proposing to reduce homeowners rates, as savings made due to catastrophe bonds and lower-cost reinsurance flow through to consumers.

The CEA has sponsored a number of catastrophe bonds in recent years, including 2011’s Embarcadero Re Ltd. (Series 2011-1) and 2012’s Embarcadero Re Ltd. (Series 2012-1) and Embarcadero Re Ltd. (Series 2012-2).

The use of cat bond risk capital, alongside fully collateralized and traditional reinsurance, as part of its reinsurance programme has helped the CEA to reduce its risk transfer costs as well as increase the amount of protection the earthquake insurer benefits from.

The benefits of cheaper reinsurance and capital markets risk transfer are about to flow through to California residents in the form of a rate reduction it seems. The CEA Advisory Panel has recommended an average rate reduction of 8%, as well as some new coverage and deductible options, to the CEA Board who meet later this year. So California homeowners could be paying less for their earthquake cover from the new year.

Glenn Pomeroy, CEO of the CEA, said that a combination of increasingly cheaper reinsurance rates along with capital market investor appetite for catastrophe bonds has helped the CEA to benefit from sufficient savings to be able to pass on a rate reduction to its customer base.

It is hoped that the reduction in rates along with new coverage options will stimulate greater uptake of earthquake cover by California residents. California earthquake penetration remains very low, with approximately 10% of homeowners said to have the additional earthquake cover.

Pomeroy said that he hoped that the savings, along with new flexible options for the deductible on the policies, will stimulate additional uptake of the cover. An increase of 1% to 2% is to be expected, Pomeroy told a local California radio station.

The CEA is also looking to increase its risk capital with a $350m debt issuance to capital market investors. This is the CEA’s first debt offering since 2006 and demonstrates that the CEA is seeking to rebuild relationships with investors in the capital markets who it may need to rely on for capital after a major earthquake event.

The CEA’s Embarcadero Re 2012-1 cat bond matures in February 2015, while its Embarcadero Re 2012-2 deal matures later next year in August 2015. It’s likely that the CEA will be looking to the ILS market for a renewal of at least some of this risk transfer, however there is no guarantee that it results in a catastrophe bond deal this time, or whether collateralized or even traditional reinsurance is more competitively priced. We will, of course, keep you posted.